2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS

Basis of Presentation

The accompanying consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), reflect the accounts of Sarepta Therapeutics, Inc. and its wholly-owned subsidiaries. All intercompany transactions between and among its consolidated subsidiaries have been eliminated. Management has determined that the Company operates in one segment: discovering, developing, manufacturing and delivering therapies to patients with DMD. The Company’s CEO, as the chief operating decision-maker, manages and allocates resources to the operations of the Company on a total company basis. The Company’s research and development organization is responsible for the research and discovery of new product candidates and supports development and registration efforts for potential future products. The Company’s supply chain organization manages the development of the manufacturing processes, clinical trial supply and commercial product supply. The Company’s commercial organization is responsible for commercialization of EXONDYS 51 in the U.S. and internationally. The Company is supported by other back-office general and administration functions. Consistent with this decision-making process, the Company’s CEO uses consolidated, single-segment financial information for purposes of evaluating performance, forecasting future period financial results, allocating resources and setting incentive targets.

Estimates and Uncertainties

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity, revenue, expenses and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the valuation of stock-based awards, research and development expenses, income tax, inventory and revenue recognition.

Reclassification

The Company has revised the presentation as well as the caption of certain cash flows from financing activities within the consolidated statements of cash flows to conform to the current period presentation. “Proceeds from exercise of options and warrants and the sale of common stock, net of offering costs” of $130.8 million and $104.2 million for the years ended December 31, 2015 and 2014, respectively, have been reclassified into “Proceeds from sales of common stock, net of offering costs” and “Proceeds from exercise of options and warrants and employee stock purchase program” and presented separately on the consolidated statements of cash flows. This revision had no impact on net cash provided by financing activities or change in cash and cash equivalents.

The Company also has revised the presentation as well as the caption of certain accrued expenses in Note 8, Accrued Expenses to the consolidated financial statements to conform to the current period presentation. “Accrued facility-related costs” of $0.1 million as of December 31, 2015 is grouped into “Other”. The reclassification had no impact on total current liabilities or total liabilities.

Additionally, the Company also has revised the presentation as well as the caption of net deferred tax assets in Note 14, Income Taxes to the consolidated financial statements to conform to the current period presentation. “Capitalized inventory” of $19.0 million as of December 31, 2015 is shown separately from “Net operating loss carryforwards” of $157.8 million and presented separately on the deferred tax assets table. The revision had no impact on net deferred tax assets or total assets.

Fair Value Measurements

The Company has certain financial assets that are recorded at fair value which have been classified as Level 1, 2 or 3 within the fair value hierarchy as described in the accounting standards for fair value measurements:

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Level 1—quoted prices for identical instruments in active markets;

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Level 2—quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

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Level 3—valuations derived from valuation techniques in which one or more significant value drivers are unobservable.

The fair value of most of the Company’s financial assets is categorized as Level 2 within the fair value hierarchy. These financial assets have been initially valued at the transaction price and subsequently valued, at the end of each reporting period, through income-based approaches utilizing observable market data. For additional information related to fair value measurements, please read Note 4, Fair Value Measurements to the consolidated financial statements.

Cash and Cash Equivalents

Only investments that are highly liquid and readily convertible to cash and have original maturities of three months or less are considered cash equivalents. As of December 31, 2016, cash equivalents were comprised of money market funds.

Available-For-Sale Debt Securities

Available-for-sale debt securities are recorded at fair market value and unrealized gains and losses are included in accumulated other comprehensive loss in stockholder’s equity. Realized gains and losses are reported in interest income and other, net, on a specific identification basis.

Accounts Receivable

The Company’s accounts receivable arise from product sales, government research contracts and other grants. They are generally stated at the invoiced amount and do not bear interest.

The accounts receivable from product sales represents receivables due from the Company’s specialty distributor and specialty pharmacies. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in the customers’ credit profile. The Company provides reserves against trade receivables for estimated losses that may result from a customer’s inability to pay. Amounts determined to be uncollectible are written-off against the established reserve. As of December 31, 2016, the credit profile for the Company’s customers is deemed to be in good standing and write-offs of accounts receivable are not considered necessary. Historically, no accounts receivable amounts related to government research contracts and other grants have been written off and, thus, an allowance for doubtful accounts receivable related to government research contracts and other grants is not considered necessary.

The following table summarizes the components of the Company’s accounts receivable for the period indicated:

	As of December 31, 2016		As of December 31, 2015
	(in thousands)
Product sales	$	4,002	$	—
Unbilled receivables		1,226		3,977
Total accounts receivable	$	5,228	$	3,977

The balance for unbilled receivables for both years presented is subject to government audit and will not be collected until the completion of the audit. The decrease in unbilled receivables is related to contract finalization and subsequent collection of the Ebola portion of the July 2010 Department of Defense contract.

Concentration of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist of accounts receivable from customers and cash, cash equivalent and short-term investments held at financial institutions.

For the year-ended December 31, 2016, the majority of the Company’s accounts receivable arose from product sales in the U.S and all customers have standard payment terms which generally require payment within 30 to 45 days. Two individual customers accounted for 80% and 16% of net product revenues and 75% and 21% of accounts receivable from product sales, respectively. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in the customers’ credit profile. As of December 31, 2016, the Company believes that such customers are of high credit quality.

As of December 31, 2016, the Company’s cash equivalents and short-term investments were concentrated at a single financial institution, which potentially exposes the Company to credit risks. The Company does not believe that there is significant risk of non-performance by the financial institution.

Inventory

Inventories are stated at the lower of cost and net realizable value with cost determined on a first-in, first-out basis. The Company capitalizes inventory costs associated with products following regulatory approval when future commercialization is considered probable and the future economic benefit is expected to be realized. EXONDYS 51 which may be used in clinical development programs are included in inventory and charged to research and development expense when the product enters the research and development process and no longer can be used for commercial purposes.

The following table summarizes the components of the Company’s inventory for the period indicated:

	As of December 31, 2016		As of December 31, 2015
	(in thousands)
Raw materials	$	9,531	$	—
Work in progress		3,175		—
Finished goods		107		—
Total inventory	$	12,813	$	—

The Company periodically reviews its inventories for excess amounts or obsolescence and writes down obsolete or otherwise unmarketable inventory to its estimated net realizable value. Additionally, though the Company’s product is subject to strict quality control and monitoring which it performs throughout the manufacturing processes, certain batches or units of product may not meet quality specifications resulting in a charge to cost of sales.

Property and Equipment

Property and equipment are initially recorded at cost, including the acquisition cost and all costs necessarily incurred to bring the asset to the location and working condition necessary for its intended use. The cost of normal, recurring or periodic repairs and maintenance activities related to property and equipment are expensed as incurred. The cost for planned major maintenance activities, including the related acquisition or construction of assets, is capitalized if the repair will result in future economic benefits. Interest costs incurred during the construction period of major capital projects are capitalized until the asset is ready for its intended use, at which point the interest costs are amortized as depreciation expense over the life of the underlying asset.

The Company generally depreciates the cost of its property and equipment using the straight-line method over the estimated useful lives of the respective assets, which are summarized as follows:

Asset Category		Useful lives
Lab equipment		5 years
Office equipment		5 years
Software and computer equipment		3 - 5 years
Leasehold improvements		Lesser of the useful life or the term of the respective lease
Land		Not depreciated
Building		30 years
Construction in Progress		Not depreciated until put into service

Intangible assets

The Company’s intangible assets consist of an in-licensed right and patent costs, which are stated in the Company’s consolidated balance sheets net of accumulated amortization and impairments, if applicable.

The in-licensed right relates to the license agreement with the University of Western Australia (“UWA”). As a result of the FDA approval and the subsequent commercial sale of EXONDYS 51, as defined in the Amended and Restated UWA License Agreement (defined in Note 3), the Company was obligated to pay a $1.0 million sales milestone to UWA and, accordingly, has recorded an in-licensed right. The in-licensed right will be amortized on a straight-line basis over the remaining life of the related patent because the life of the related patent reflects the expected time period that the Company will benefit from the in-licensed right. The amortization of the in-licensed right is recorded as cost of sales in the Company’s consolidated statements of operations and comprehensive loss. As of December 31, 2016, the Company recorded less than $0.1 million cost of sales related to the amortization of the in-license right.

Patent costs consist primarily of external legal costs, filing fees incurred to file patent applications and renewal fees on proprietary technology developed or licensed by the Company. Patent costs associated with applying for a patent, being issued a patent and annual renewal fees are capitalized. Costs to defend a patent and costs to invalidate a competitor’s patent or patent application are expensed as incurred. Patent costs are amortized on a straight-line basis over the shorter of the estimated economic lives or the initial term of the patents, which is generally 20 years. Patent amortization expense was $0.6 million, $0.5 million and $0.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company also expensed the remaining net book value of previously capitalized patents that were later abandoned of $0.3 million, $0.2 million and $0.1 million for the years ended December 31, 2016, 2015 and 2014, respectively, which were included in research and development expenses on the consolidated statements of operations and comprehensive loss.

The following table summarizes the estimated future amortization for intangible assets for the next five years:

	As of December 31, 2016 (in thousands)
2017	$	705
2018		704
2019		698
2020		670
2021		652
Total	$	3,429

Impairment of Long-Lived Assets

Long-lived assets held and used by the Company and intangible assets with definite lives are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Such reviews assess the fair value of the assets based upon estimates of future cash flows that the assets are expected to generate.

Revenue Recognition

The Company recognizes revenue when all of the following criteria are met:

persuasive evidence of an arrangement exists;

delivery has occurred or services have been rendered;

price to the customer is fixed or determinable; and

collectability is reasonably assured.

Product revenues

Revenue from product sales is recognized when title and risk of loss have passed to the customer and is recorded net of applicable reserves for discounts and allowances.

Reserves for discounts and allowances

The Company establishes reserves for various government rebate and chargeback programs and co-payment assistance. Reserves established for these discounts and allowances are classified as either reductions of accounts receivable or a liability. These reserves are based on estimates of the amounts earned or to be claimed on the related sales. Product revenue reserves represent the Company's estimates of outstanding claims for end-user rebate-eligible sales that have occurred, but for which related claim submissions have not been received. They are categorized as follows:

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Medicaid rebates relate to the Company’s estimated obligations to states under established reimbursement arrangements. Rebate accruals are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a liability which is included in other current liabilities.

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Governmental chargebacks, including Public Health Service (“PHS”) chargebacks, represent the Company’s estimated obligations resulting from contractual commitments to sell products to qualified healthcare providers at prices lower than the list prices that the Company charges to wholesalers. The wholesaler charges the Company for the difference between what the wholesaler pays for the products and the ultimate selling price to the qualified healthcare providers. Chargeback reserves are established in the same period as the related revenue is recognized, resulting in a reduction in product revenue and accounts receivable. Chargeback amounts are generally determined at the time of resale to the qualified healthcare provider from the wholesaler, and the Company generally issues credits for such amounts within a few weeks of receiving notification of resale from the wholesaler.

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Copay represents financial assistance to qualified patients, assisting them with prescription drug co-payments required by insurance. The copay reserves are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a liability which is included in other current liabilities.

The Company also expects to maintain certain customer service contracts with distributors and other customers in the distribution channel that will provide inventory management, data and distribution services, which generally will be reflected as a reduction of revenue. To the extent the Company can demonstrate a separable benefit and fair value for these services, the Company will classify these payments as selling, general and administrative expenses.

Revenue from research contracts and other grants

The Company’s contracts with the U.S. government are cost plus contracts providing for reimbursed costs which include overhead and general and administrative costs and a target fee. The Company recognizes revenue from government research contracts during the period in which the related expenses are incurred and presents such revenues and related expenses on a gross basis in the consolidated financial statements. The Company’s government contracts are subject to government audits, which may result in catch-up adjustments. As of December 31, 2014, the Company had completed all development activities under its contracts with the U.S. government. The majority of the revenue under government contracts was recognized as of December 31, 2016 and only revenue for contract finalization, if any, is expected in the future.

Deferred revenue

If a technology, right, product or service is separate and independent of our performance under other elements of an arrangement, the Company defers recognition of non-refundable up-front fees if it has continuing performance obligations when the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee. In addition, if the Company has continuing involvement through research and development services that are required because of its know-how or because the services can only be performed by the Company, such up-front fees are deferred and recognized over the period of continuing involvement. As of December 31, 2016, the Company had deferred revenue of $3.3 million, which represents up-front fees which it may recognize as revenue upon settlement of certain obligations.

Research and Development

Research and development expenses consist of costs associated with research activities as well as those with the Company’s product development efforts, conducting preclinical studies, clinical trials and manufacturing activities. Research and development expenses are expensed as incurred. Up-front fees and milestones paid to third parties in connection with technologies which have not reached technological feasibility and do not have an alternative future use are expensed when incurred. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities pursuant to an executory contractual arrangement will be deferred and capitalized, and recognized as an expense as the related goods are delivered or the related services are performed. If the Company does not expect the goods to be delivered or services to be rendered, the advance payment capitalized will be charged to expense.

Direct research and development expenses associated with the Company’s programs include clinical trial site costs, clinical manufacturing costs, costs incurred for consultants and other external services, such as data management and statistical analysis support and materials and supplies used in support of clinical programs. Indirect costs of the Company’s clinical programs include salaries, stock-based compensation and an allocation of its facility costs.

When third-party service providers’ billing terms do not coincide with the Company’s period-end, the Company is required to make estimates of its obligations to those third parties, including clinical trial and pharmaceutical development costs, contractual services costs and costs for supply of its drug candidates, incurred in a given accounting period and record accruals at the end of the period. The Company bases its estimates on its knowledge of the research and development programs, services performed for the period, past history for related activities and the expected duration of the third party service contract, where applicable.

Stock-Based Compensation

The Company’s stock-based compensation programs include stock options, restricted stock awards (“RSAs”), restricted stock units (“RSUs”), stock appreciation rights (“SARs”) and employee stock purchase program (“ESPP”). The Company accounts for stock-based compensation using the fair value method.

The fair values of stock options and SARs are estimated on the date of grant using the Black-Scholes-Merton option-pricing model. The fair values of RSAs and RSUs are based on the fair market value of the Company’s common stock on the date of the grant. The fair value of stock awards, with consideration given to estimated forfeitures, is recognized as stock-based compensation expense on a straight-line basis over the vesting period of the grants. For stock awards with performance-vesting conditions, the Company does not recognize compensation expense until it is probable that the performance-vesting condition will be achieved.

Under the Company’s ESPP, participating employees purchase common stock through payroll deductions. The purchase price is equal to 85% of the lower of the closing price of the Company’s common stock on the first business day and the last business day of the relevant purchase period. The fair values of stock purchase rights are estimated using the Black-Scholes-Merton option-pricing model. The fair value of the look-back provision plus the 15% discount is recognized on a graded-vesting basis as stock-based compensation expense over the purchase period.

Income Taxes

The Company follows the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. It is the intention of the Company to reinvest the earnings of its non-U.S. subsidiaries in those operations and not to repatriate the earnings to the U.S. Accordingly, the Company does not provide for deferred taxes on the excess of the financial reporting over the tax basis in its investments in foreign subsidiaries as they are considered permanent in duration. To date, the Company has not had any earnings in its non-U.S. subsidiaries.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered and settled. A valuation allowance is recorded to reduce the net deferred tax asset to zero because it is more likely than not that the net deferred tax asset will not be realized. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained upon an examination.

Rent Expense

The Company’s operating leases for its Cambridge, Massachusetts and Corvallis, Oregon facilities provide for scheduled annual rent increases throughout each lease’s term. The Company recognizes the effects of the scheduled rent increases on a straight-line basis over the full term of the leases.

For the years ended December 31, 2016, 2015 and 2014, the Company recognized rent expense and occupancy costs of $5.6 million, $5.2 million and $4.4 million, respectively.

Commitments and Contingencies

The Company records liabilities for legal and other contingencies when information available to the Company indicates that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Legal costs in connection with legal and other contingencies are expensed as costs are incurred.

Subsequent Events

On February 21, 2017, the Company entered into an agreement to sell its Rare Pediatric Disease Priority Review Voucher (“PRV”). The Company received the PRV when EXONDYS 51was approved by the FDA for the treatment of patients with DMD amenable to exon 51 skipping. As part of the agreement, the Company will receive an up-front payment of $125.0 million upon the closing of the transaction, which is subject to customary closing conditions and is expected to occur following expiration of the applicable U.S. antitrust clearance requirements. Subsequent events have been evaluated up through the date that these consolidated financial statements were filed and no other material subsequent events were identified.

Recent Accounting Pronouncements

In November 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-18, “Statement of Cash Flows: Restricted Cash”. The amendments in this update requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU No. 2016-18 will be effective for fiscal years beginning after December 15, 2017, with early adoption permitted. As of December 31, 2016, the Company has not elected to early adopt this guidance but expect the adoption of this guidance to have an impact on its statements of cash flows. The cash and cash equivalents balance at beginning of period and end of period would have increased by approximately $11.5 million had the guidance been adopted as of December 31, 2016.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”. The amendments in this update clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 will be effective for fiscal years beginning after December 15, 2017, with early adoption permitted. As of December 31, 2016, the Company has not elected to early adopt this guidance but does not expect the adoption of this guidance to have any impact on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting”. The amendments in this update simplify several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU No. 2016-09 will be effective for fiscal years beginning after December 15, 2016, with early adoption permitted. This standard will be effective for the Company on January 1, 2017. The Company has determined that the adoption of this standard will not have any impact on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”, which supersedes Topic 840, “Leases”. Under the new guidance, a lessee should recognize assets and liabilities that arise from its leases and disclose qualitative and quantitative information about its leasing arrangements. ASU No. 2016-02 will be effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The adoption of this standard is expected to have an impact on the amount of the Company’s assets and liabilities. As of December 31, 2016, the Company has not elected to early adopt this guidance and is currently evaluating the potential impact that this standard will have on the Company’s consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes”. The new standard requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position. ASU No. 2015-17 will be effective for fiscal years beginning after December 15, 2016, with early adoption permitted. This standard will be effective for the Company on January 1, 2017. The Company has determined that the adoption of this standard will not have any impact on its consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory”. The new standard applies only to inventory for which cost is determined by methods other than last-in, first-out and the retail inventory method, which includes inventory that is measured using first-in, first-out or average cost. Inventory within the scope of this standard is required to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new standard will be effective for fiscal years beginning after December 15, 2016. As of December 31, 2016, the Company has elected to early adopt this guidance. The adoption of this standard did not have any impact on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. This update requires an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued or available to be issued and to provide related disclosures. ASU No. 2014-15 will be effective for the fiscal years ending after December 15, 2016, with early adoption permitted. The Company has adopted this guidance as of December 31, 2016. Based on the Company's financial condition as of the date these consolidated financial statements were issued or available for issuance, the adoption of this guidance did not have any impact on the current period consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, “Revenue Recognition”. Under the new guidance, a company is required to recognize revenue when it transfers goods or renders services to customers at an amount that it expects to be entitled to in exchange for these goods or services. The new standard allows for either a full retrospective with or without practical expedients or a retrospective with a cumulative catch upon adoption transition method. This guidance was originally intended to be effective for the fiscal years beginning after December 15, 2016, with early adoption not permitted. In August 2015, the FASB issued ASU No. 2015-14, “Deferral of the Effective Date”, which states that the mandatory effective date of this new revenue standard will be delayed by one year, with early adoption only permitted in fiscal year 2017. During the second quarter of 2016, the FASB issued three amendments to the new revenue standard to address some application questions: ASU No. 2016-10, “Identifying Performance Obligations and Licensing”, ASU No. 2016-11, “Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09”, and ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients”. In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers”, which amends certain narrow aspects of the guidance issued in ASU 2014-09 including guidance related to the disclosure of remaining performance obligations and prior-period performance obligations, as well as other amendments to the guidance on loan guarantee fees, contract costs, refund liabilities, advertising costs and the clarification of certain examples. These three amendments will be effective upon adoption of Topic 606. As of December 31, 2016, the Company has not yet determined which adoption method it will utilize or the effect that the adoption of this guidance will have on its consolidated financial statements. As the Company just launched its first Commercial product in September 2016, it expects that the financial impact from this guidance through December 31, 2016 will be immaterial.